Stress testing: A look into the Fed’s black box

At a glance

On March 26th, the Federal Reserve (Fed) announced the results of its annual Comprehensive Capital Analysis and Review (CCAR). This year the Fed assessed the capital plans of 30 bank holding companies (BHCs) – 12 more than last year – and objected to five plans (four due to deficiencies in the quality of capital planning process, and one for falling below quantitative minimum capital ratios). Two other US BHCs had to “take a mulligan” and quickly resubmit their plans with reduced capital actions to remain above the quantitative floors.

The CCAR 2014 results send two overarching messages: The quality of the capital planning process is now a more prominent aspect of the Fed’s focus (versus just the quantity of capital), and the bar continues to rise, especially for the largest firms. Therefore, BHCs must continue to improve their capital planning processes regardless of whether they meet quantitative capital requirements.

Fed objections this year covered both US and foreign-owned BHCs. Three of the six largest US BHCs were unable to make desired capital distributions, in part due to the Fed using its own forecasting models for the first time (rather than relying on the BHCs’ models). In addition, half of foreign-owned BHCs’ plans (again, three of six) were rejected due to qualitative issues. These outcomes suggest that the Fed will likely continue to use its models to exert downward pressure on stressed capital ratios to keep capital in the system, supplemented by its heightened qualitative assessments.

This A closer look provides our quantitative and qualitative analyses of the CCAR 2014 results and lessons learned, and our view of enhancements needed to meet increasingly heightened regulatory expectations.